by Stephen Reed | Accounting News, News, Newsletter, Retirement Savings
More Americans are turning to a 401(k) hardship withdrawal to cover urgent and unexpected expenses. By the end of 2024, about 5% of employees had taken a hardship withdrawal from their 401(k) accounts. That’s more than double the 2% who did so in 2018. With inflation, housing, and healthcare costs rising, Americans are having difficulty saving for emergencies, so they’re finding alternative ways to afford unexpected expenses, including hardship withdrawals from retirement funds. Is this a smart move? Here’s when a hardship withdrawal does and doesn’t make sense.
What Is a 401(k) Hardship Withdrawal?
A hardship withdrawal is money taken out of a 401(k) or traditional IRA for what the IRS deems an “immediate and heavy financial need.” You can pull funds early without incurring the usual 10% early withdrawal penalty as long as the withdrawal meets certain criteria. However, these withdrawals are still subject to standard income taxes. And unlike a 401(k) loan, it can’t be paid back.
Common hardship reasons include:
- Medical expenses
- Funeral costs
- Preventing foreclosure or eviction
- Tuition and educational fees
- Repairing damage to your home from a natural disaster
When a Hardship Withdrawal Might Be the Right Move
A hardship withdrawal can make sense if:
- You’ve exhausted all other options, such as tapping emergency savings or inquiring about payment plans for your hardship
- The expense is time-sensitive and unavoidable
- You’re facing a medical emergency, a foreclosure, or an eviction
- You won’t need to withdraw from your 401(k) again in the foreseeable future
Just be aware that a hardship withdrawal means you’re shrinking your future nest egg, possibly by tens of thousands, depending on the amount you withdraw, your age, and market returns.
When a 401(k) Hardship Withdrawal Is Probably Not Worth It
It’s best to avoid taking a hardship withdrawal for credit card debt, vacations, monthly expense catch-ups, and home upgrades (unless for disaster repairs).
Retirement savings should not be used as a financial band-aid. If you find yourself in the position of contemplating a hardship withdrawal to cover routine expenses and self-incurred debt, it’s time for a budget overhaul.
Also consider that you’re still taxed on the withdrawal, so taking out $10,000 would only mean $7,000 or $8,000 after taxes.
Alternatives to Consider
Before tapping your 401(k), here are some other options to explore:
- A personal loan or home equity loan (as long as the interest rate is reasonable)
- A 401(k) loan. This is not the same as a withdrawal. You repay the loan over time with interest.
- Contact your creditors to set up a payment plan
- Seek help from nonprofit financial counseling services
These options may provide short-term relief without resorting to something as drastic as a 401(k) hardship withdrawal.
by Stephen Reed | Accounting News, News, Newsletter, Retirement, Retirement Savings
Retirement should be a time to finally relax, but concerns about depleting savings can cast a shadow over your golden years. In this article, we’ll delve into smart money moves that can help ensure a more secure and comfortable retirement.
Set Up a Safe Withdrawal Rate
A safe withdrawal rate is the percentage of your retirement savings that you can tap into annually without risking running out of money during your lifetime. A common strategy is the 4% rule, which suggests withdrawing 4% of your retirement savings each year, creating a sustainable income stream while preserving your principal. This approach takes into account market fluctuations and adjusts your withdrawals accordingly. For example, in thriving market conditions, you might withdraw a bit more, while in downturns, you might cut back.
Diversifying your investments is another key factor in managing the safe withdrawal rate. A well-balanced portfolio can help mitigate risks and generate returns, ensuring that your retirement savings remain resilient over time.
Delay Social Security
You are eligible to receive your full Social Security benefit, determined by your individual earnings history, upon reaching full retirement age (FRA), which varies depending on your birth year. However, opting to postpone your application beyond FRA offers the advantage of increasing your monthly benefits by 8% annually, up to the age of 70.
While an increased Social Security benefit doesn’t necessarily ensure your savings won’t deplete, the extra funds each month would contribute to preserving your savings and maximizing your overall retirement income.
Annuities
Annuities are financial products designed to provide a steady income stream during retirement. They can be an excellent option for those worried about outliving their savings. Annuities come in various forms, such as immediate annuities and deferred annuities, each offering distinct advantages.
Immediate annuities involve a lump-sum payment in exchange for guaranteed monthly payments for life. This can be a reliable way to secure a fixed income stream, regardless of market fluctuations. Deferred annuities, on the other hand, allow you to invest a sum of money that grows over time and is converted into periodic payments later in retirement.
Annuities provide a predictable cash flow, but be sure to carefully evaluate the terms and conditions, fees, and potential risks associated with them before making a decision. Also keep in mind that, unlike Social Security, annuities work on a fixed amount and don’t adjust with inflation. Consulting with a financial advisor can help you navigate the complexities and choose an annuity that aligns with your financial goals.
Securing a worry-free retirement requires thoughtful planning and smart financial strategies that are tailored to your unique circumstances. Consult with a financial professional to ensure that your retirement plan aligns with your long-term goals.
by Jean Miller | Accounting News, News, Retirement, Retirement Savings
Retirement planning involves careful consideration of various financial strategies, and while traditional retirement accounts such as 401(k)s and IRAs are still go-to options, the Health Savings Account (HSA) is becoming a valuable retirement tool. Here’s why.
What is an HSA?
A Health Savings Account (HSA) is a tax-advantaged savings account that allows individuals to set aside funds especially for medical expenses. It is intended to work jointly with a high-deductible health plan (HDHP), which is a type of health insurance plan with lower premiums but higher deductibles compared to traditional health insurance plans. Though it was originally designed to help individuals cover medical expenses, the HSAs has evolved to offer unique advantages that make it an increasingly attractive option for saving for retirement.
An Increase in Maximum Contributions
The IRS recently announced the largest-ever increase in maximum contributions to HSA accounts. In 2024, the maximum HSA contribution will be $4,150 for an individual (up from $3,850) and $8,300 for a family (up from $7,750). Add to this the bonus $1,000 individuals over 55 can contribute, and the maximum contributions are $5,150 for individuals and $10,300 for couples.
Triple-Tax Advantage
Contributions made to HSAs are tax-deductible, meaning that individuals can lower their taxable income by the amount contributed. Additionally, earnings on the funds within the account grow tax-free. Finally, withdraws from an HSA for qualified medical expenses are also tax-free.
Long-Term Savings Potential
Unlike flexible spending accounts (FSAs), which typically must be used by the end of the year, HSAs offer an opportunity for long-term growth as they are not subject to an annual deadline for spending. HSA funds can be invested in stocks and other securities, potentially allowing for higher returns over time. Because of this, individuals can accumulate substantial savings in HSAs to supplement their retirement income.
Medicare Premium Payments
HSA funds can be used to pay for Medicare premiums, including Medicare Part B, Part D, and Medicare Advantage premiums, deductibles, copays, and coinsurance. By utilizing HSA funds for these expenses, individuals can free up their retirement savings in other accounts, such as 401(k)s or IRAs, for other essential expenses or investments.
Healthcare Costs in Retirement
HSAs can serve as a dedicated savings tool for healthcare costs in retirement. Savers can build up a substantial nest egg dedicated specifically to healthcare expenses – including premiums, deductibles, and other out-of-pocket costs – by maximizing contributions to their HSAs during their years in the workforce.
Flexibility and Portability
Unlike traditional retirement accounts that have required minimum distributions (RMDs) starting at age 72, HSAs do not have RMDs. This allows individuals to retain control over their funds and decide when and how they want to use them. Additionally, HSAs are portable, meaning they move with the account holder from job to job, in between employment, or even into retirement. This provides individuals with consistent access to savings.
As healthcare costs continue to rise, individuals who incorporate HSAs into their retirement planning strategy can bolster their financial security and ensure they are well-prepared for any healthcare expenses in their golden years.
by Pete McAllister | Accounting News, News, Retirement, Retirement Savings, Tax Planning, Tax Planning - Individual
A key approach to minimizing taxes, especially as you near retirement, is to implement tax planning strategies that can help you save money and maximize your retirement savings. Here are some tax-efficient strategies to consider.
Contribute to Tax Advantage Retirement Accounts
When you contribute to a retirement account such as a 401(k), IRA, and Roth IRA, you can lower your taxable income in the year you make the contribution. With a traditional 401(k), you defer income taxes on contributions and earnings, which means you won’t pay taxes on them until you withdraw the funds in retirement. With a Roth IRA, your contributions are made after taxes and your earnings may be withdrawn tax-free in retirement.
Utilize Catch-Up Contributions
Workers over the age of 50 are eligible for an additional tax break when they make catch-up contributions to retirement accounts. In 2023 individuals can contribute an additional $1,000 to an IRA (up to $7,500 in total). For 401(k) plans, individuals can contribute an additional $7,500 for a total tax-deductible contribution of as much as $30,000. Catch-up contributions help to save more for retirement and reduce taxable income.
Consider a Health Savings Account
A Health Savings Account (HSA) is a tax-advantaged savings account that can be used to pay for qualified medical expenses. If you have a high-deductible health plan, you may be able to contribute to an HSA. The contributions are tax-deductible, the earnings grow tax-free, and you can withdraw the funds tax-free in retirement to pay for qualified medical expenses.
Make Use of the Saver’s Credit
In order to be eligible for the saver’s credit in 2023, you must contribute to a 401(k) or IRA and earn up to $36,500 for individuals, $54,7500 for heads of household, and $73,000 for married couples. You can claim the saver’s credit on retirement account contributions of up to $2,000 ($4,000 for couples). Depending on your income, it is worth between 10% and 50% of the amount contributed (bigger credits go to lower-income savers). The saver’s credit may be claimed in addition to the tax deduction for traditional retirement account contribution.
Refrain from Triggering the Early Withdrawal Penalty
You could be subject to a 10% tax penalty if you make IRA withdrawals before age 59 ½ and 401(k) withdrawals before age 55. The penalty may be avoided for certain specific purchases such as:
- Up to $10,000 for a first home purchase
- College costs
- Extensive health care costs
- Health insurance following a layoff from your job
If a Roth IRA is at least five years old, you may be able to withdraw funds that you contributed, but not the earnings, without prompting the early withdrawal penalty.
Don’t Sleep on Required Minimum Distributions
After age 73, savers are generally required to take required minimum distributions (RMDs) from IRAs and 401(k)s, and income tax will be owed on each distribution. Should you withdraw the incorrect amount, you could be subject to a 25% penalty of the amount that should have been withdrawn. This is in addition to the income tax due. However, if you act quickly to amend the error, that penalty could drop to 10%. Your first RMD is due by April 1 of the year after you turn 73. All following distributions must be taken by Dec. 31 each year in order to avoid the penalty.
Put Off 401(k) Withdrawals if You’re Still Employed
If you are still employed in your 70s and beyond, you may be able to delay withdrawals from your 401(k) account until your retirement (provided you don’t own more than 5% of the company sponsoring the retirement plan). Just be aware that after age 75, you will still be required to take RMDs from IRAs and 401(k)s associated with previous jobs in order to avoid the 25% tax penalty.
Plan Your Withdrawals
When you start withdrawing funds from your retirement accounts, plan in a way that minimizes taxes. For instance, you can withdraw funds from taxable accounts first to avoid triggering taxes on Social Security benefits. During your 60s, you can take penalty-free withdrawals from your retirement accounts without being required to take distributions each year. You can also take advantage of tax-efficient withdrawal strategies, such as the bucket approach, which involves dividing your assets into different buckets based on when you plan to use them.
by Stephen Reed | Accounting News, News, Retirement, Retirement Savings
Retirees routinely withdraw cash from retirement accounts to cover basic living expenses, but selling low could negatively affect your retirement portfolio. If the economy experiences a downturn during your retirement years, you can use the strategies discussed below to minimize the impact to your long-term financial plan.
Before Making Any Withdrawals
While younger investors are generally advised to leave their cash invested and wait for the market to rebound, retirees typically rely on market withdrawals to create cash flow. In an effort to avoid or postpone withdrawals during tricky market conditions, try to find assets unlinked to the market that you can tap into until the market normalizes. Market downturns and steep inflation can be considered financial emergencies if you’re struggling to make ends meet, so you can certainly dip into emergency funds without feeling guilty. Just be sure to prepare a plan to replenish the funds as soon as possible. If you must withdraw from your investment accounts, it’s important to be strategic in your withdrawals.
Begin with Interest and Dividends
Before selling low, try to leave your original investment intact by only withdrawing the interest and dividends from your taxable accounts. This move could allow you to conceivably grow your income when the market rebounds in the future.
Sell Lower Volatility Investments
Short-term bonds and bond funds generally aren’t as affected by market unpredictability, and their values are ordinarily stable. Selling them in a down market can supply necessary cash and not cause too much damage to your retirement savings. They also favor smaller price fluctuations than stocks during stretches of market volatility.
Rebalance Your Portfolio
If your investment portfolio is out of alignment with your asset allocation goals due to market volatility, it’s an opportune time to look for opportunities to raise needed cash by rebalancing. In order to return your allocation to its original goal, sell assets where values have increased disproportionately in value relative to your desired allocation, and buy assets that may have dropped in value.
Make Tax-Smart Choices
If you’re forced to sell assets from taxable accounts for needed cash flow, be sure to make tax-smart choices. You can minimize your taxes owed by selling investments that you’ve held longer than one year. Those gains are taxed at the long-term capital gains tax rate of 20% and not at the federal ordinary income tax rate. Keep in mind that some gains may also be subject to state and local taxes.
